Email this article to a friend

State-run retirement reserve funds are becoming some of the most successful investors in Europe. The funds, created to address the shortfall in the state-run, pay-as-you-go pensions, have rapidly built expertise in asset allocation and manager selection that puts many privately run pension schemes to shame.

The €13.3bn ($16.3bn) National Pensions Reserve Fund in Ireland reported a record return of 7.9% in the first six months of the year, after deciding to overhaul its investment approach.

The strong performance of state-run schemes raises the prospect that investing to fund retirement might best be handled by governments, rather than by individuals or companies.

Many of Europe’s state-run reserve funds have far more adventurous asset allocation than is commonly seen in private sector schemes. They tend to manage a large portion of their assets internally, but also use external managers for specialist briefs.

In the UK, it has been suggested that a state-run fund could offer a solution to its pension crisis. In its submission to the Pension Commission, the CBI, the UK employers’ body, said the second state pension could be run by the state but with investment outsourced to fund management.

This model is already in use in Sweden, where the state-sponsored AP1 and AP3 retirement funds posted record returns of 8.4% and 8.6% respectively in the first six months of the year.

It is compulsory for Swedish workers to put 2.5% of their gross income into the state-run scheme. However, they can choose investment strategy themselves, if they so wish, with more than 600 funds available for investment.

According to the CBI, one of the strengths of such state-run schemes is that pooling individuals’ contributions slashes administration costs, thereby increasing retirement income.

The Pension Commission, which is seeking a solution to the UK pensions problem, found that administration costs can eat up 30% of private pension funds for low earners.

Anthony Thompson, head of pensions policy at the CBI, said the economies of scale in a state-sponsored second-tier pension would cut administrative costs and leave workers with higher pensions.

The CBI has yet to decide if contributions to such a fund should be voluntary or compulsory, but noted that several countries had similar systems that delivered pension savings at far lower cost than those in the UK.

The main Swedish AP buffer funds were set up in 1999 when the holdings from earlier state pension funds were distributed equally among them.

Richard Tyszkiewicz, director of European business development at the consultancy Bfinance, said: “The Swedish model is fairly unique insofar as it’s one large fund split into several smaller funds. Each one has broadly the same investment profile so they are effectively competing against one another.”

During the spring, a government-sponsored report on the AP funds’ operations was critical of the low level of risk taken by the funds compared with their targets, since their long-term returns differed only slightly from relevant indices. The report also said the funds’ expenses were disproportionately high in relation to the asset management activities.

The funds have been responding to the challenge by cutting costs and by introducing more active risk management across their portfolios.

The first half of this year has seen a restructuring of the AP2 fund, with 22 mandates being terminated in Swedish equity, hedges and foreign equities.

Management of the fund’s assets is increasingly handled in-house with a greater diversification of risk. Global mandates are expected to form a growing portion of the funds.

AP3 has also opted to further diversify its portfolio by adding emerging markets and increasing exposure to international real estate and small-cap listed research companies in the pharmaceutical sector.

The €140bn Norwegian Pensions Reserve Fund, which invests Norway’s surplus oil wealth in foreign stocks and bonds, is often cited as a model for other reserve funds. The strategic benchmark puts 60% in fixed income and 40% in equities, with half invested in Europe and America, Asia and Oceania.

Norges Bank, which runs the fund, outsources some management of assets to external equity and fixed income specialists. At the end of the second quarter of 2005, 22% of the fund was managed by external managers.

Tyszkiewicz at Bfinance believes the Norwegian fund’s consistently high returns can be partly attributed to the internal infrastructure at Norges Bank and the amount of resources available.
He said: “Everything is done in-house, and they have six-year studies done on the effectiveness of fund managers.”

Risk has been low, and few of the fund managers have been replaced over the past five years.
The Irish National Pensions Reserve Fund, created to provide partial funding of pensions from 2025, has had an investment makeover in the past year.

Donal Geaney, the fund’s chairman, said considerable progress had been made on the diversification of the fund’s investment base, which was announced in February.

The initial strategic allocation decided in 2001 was 80% to equities and 20% to bonds.
After studying the strategies of the world’s biggest endowment funds – Harvard, Yale and the Ford family – it was decided last year to allocate 18% of the fund to alternative investments.

Geaney said: “The overall aim of the diversification exercise is to increase the fund’s potential return without substantially altering its risk profile. By the end of 2009, the commission aims to invest 8% of the fund in both property and private equity, equal to about €2bn in each asset class.”

Some €200m has recently been committed to international property while there has been initial funding of €75m to private equity and €120m to commodities.

The Fonds de Réserve pour les Retraites, the €23bn French state pension reserve fund, is the newest reserve fund on the block and has yet to invest about a third of its assets.

At the end of 2004, the fund had 25.6% of its assets invested in equities, 7.8% in bonds, and 66.6% in cash, from which it accrued interest of €306.6m. Across its assets, the fund returned 3.98% in 2004, while the total return on equity and bond investments was 9.46%.

On the other side of the spectrum, The Belgian Silver Fund, created in 2001 to cover the costs of an ageing population, has proved to be conservative and fixed in its investment strategy. Despite pressure from the market, the government will not allow the fund to diversify its portfolio outside of government bonds.

Investment consultants are sceptical as to whether corporate pension funds can learn anything in terms of asset allocation and manager selection from these reserve funds.

UK corporate schemes differ significantly from these large funds and have different priorities, according to Vince McEntegart, senior investment consultant at Hymans Robertson.

He said: “For the next few years, corporate schemes will have to focus on quantifying their deficit and on how to address their shortfall, whereas these reserve funds won’t have to start paying out for another 20 years or so.”